IRDAI’s Latest Guidelines on Executive Compensation – An Equity Compensation Perspective

Written By:
Umashankar Acharya
September 5, 2023

With a view to bring-in further reforms in the Executive Compensation in Insurance Companies in India, the Insurance Regulatory and Development Authority of India (“IRDAI”) has recently notified new Guidelines in replacement of earlier one. The new Guidelines have significantly redefined the role of Equity compensation (“ESOPs”) among other things. This write-up seeks to analyze and highlight the important provisions with  particular reference to ESOPs in the new regime.

1. Background

1.1 Insurance companies are an important part of the overall financial system. Executive compensation in some insurance companies tended to base on short-term profits without adequate linkage to the long-term risks emanating from such executives’ decisions or actions. The bonuses / incentives at times used to encourage excessive risk taking by the executives resulting in a potential threat to the financial system 

1.2 Keeping these in view and also in alignment with the norms of the Financial Standards Board, recommendation of International Association of Insurance Supervisors, G-20 Nations Forum, and Basel Committee on Banking Supervision, the Insurance Regulatory and Development Authority of India (“IRDAI”) had issued guidelines (“Erstwhile Guidelines”) on 5th August2016 seeking to govern the remuneration of Non-executive Directors (“NEDs”),Chief Executive Officer (“CEO”), Whole-time Directors (“WTDs”) and Managing Director (“MD”) of private sector insurance companies in India

1.3 Upon observation of the workings of the Erst while Guidelines up till now and with a view to bring-in further reforms while keeping the original spirit intact, the IRDAI has issued the ‘Guidelines on Remuneration of Directors and Key Managerial Persons of Insurers’ (“New Guidelines”) on 30th June 2023 which has superseded and replaced the Erst while Guidelines.

1.4 These New Guidelines have become effective from the financial year 2023-24 and shall apply to all private sector insurers(“Insurance Company”) excluding the Foreign Re-insurance Branches operating in India

1.5 The New Guidelines are broadly distinguished from the predecessor on account of the following additional provisions as to:

a) Coverage of the remuneration of Key Managerial Persons (“KMPs”); and

b) Redefinition of aspects of Variable pay (“VP”) including mandatory component of Share-linked Instruments, new norms of ratio of VP with the Fixed pay (“FP”), VP deferral, malus and claw back, accounting and disclosures requirements.

1.6 This write-up is primarily oriented towards the Share-linked Instruments (“ESOPs”) referred to in these New Guidelines and seeks to analyze and highlight the important provisions besides finding-out whether any provision may create difficulties or need further clarity

2. Our analysis and views

2.1   The New Guidelines govern the remuneration of (i) NEDs, on one hand and (ii) KMPs   (including WTDs/ CEO/ MD) on the other. As the NEDs are not eligible for any equity linked compensation, the aspects of their remuneration are not further discussed here.

2.2 Aspects of remuneration of KMPs      

It is important to know who is or may be classified as a KMP. As per statutory definition given in the IRDAI (Registration of Indian Insurance Companies)Regulations, 2022, this term    includes members of the core management team including all WTDs, CEO, MD and the functional heads one level below the MD or the CEO, including the Chief Financial Officer, Appointed Actuary, Chief Investment Officer, Chief Risk Officer, Chief Compliance Officer, and the Company Secretary. It seems that the Chief Human Resources Officer, Chief Information Officer, Chief Marketing Officer and other CXOs, if any, may be covered subject to their being one level below the MD or the CEO.

2.3 A comparative study of key provisions in Erstwhile Guidelines and that in the New Guidelines may be helpful for a quick understanding of the current position:

1 However, in case an interpretation is made basis what other regulators have prescribed and with reference to applicable accounting standard, valuation basis Fair Value of ESOPs (as specified for listed insurance Companies in the New Guidelines) seems Appropriate.

3. Overall impact and points needing clarity 

3.1 Earlier, ESOPs were not counted as a part of total compensation; however, the New Guidelines changed this scenario.

3.2 The new ceilings of ESOPs in terms of grant of 1% per year in case of an unlisted Insurance Company, with an overall ceiling of 5% of the paid-up equity capital for all type of Insurance Companies (both listed and unlisted) seem to impact the VP of KMPs adversely, particularly when the conversion of the non-cash VP would require more than 1% in a given pay cycle and over the years, the total number of ESOPs granted may reach the overall ceiling.

3.3 Even though the New Guidelines are clear, few aspects need clarity like whether reference to the “fair value of the equity shares” of an unlisted company for the purpose of determination of ESOP entitlement of its KMPs should be read as “fair value of the ESOPs” as this understanding seems in due alignment with what is stated in the context of listed Insurance Companies.

3.4 Further, while referring to “fair value of ESOPs”, prescription as to the methodology for such valuation seems highly desirable as may bring uniformity and ease of compliance across wide cross-section of Insurance Companies in India.

3.5 The New Guidelines require linking of the fate of VPs including the vested or unvested ESOPs with the deterioration in the financial performance, known as malus and claw back. For effective legal enforcement, it requires scenario building and appropriate communication with the KMPs primarily in their employment agreement as to in which circumstance(s) malus and claw-back would trigger.

3.6 Given the new approach for ESOPs, the existing ESOP policy and practice may be

checked for any potential inconsistency and be aligned so as to ensure compliance in letter and spirit. The new regime though limits the quantum of ESOPs (as a part of VP)at the time of grant, but does not cap the eventual upside in their value accruing at the time of exercise and consequent sale of shares. This connotes value proposition for a growing Insurance Company seeking to bring win-win for all its stakeholders

Disclaimer: Our views in this compilation are matter of our understanding/ interpretation of the subject and relevant legal/ regulatory provisions. Being a bona fide compilation, we disclaim any liability of whatsoever nature towards any reader or other person unless expressly agreed to by us in writing.

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Umashankar Acharya

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